Income Investors are Going to Hate this Tax Plan

With resistance growing to the GOP’s border adjustment tax, The Wall Street Journal reports on a truly heinous plan B to fund a corporate tax cut. This half-baked plan comes courtesy of the American Enterprise Institute.

The AEI plan would cut corporate taxes to 15% and pay for the reduction by taxing dividends and capital gains at ordinary income rates (that’s 39.6% pre-Obamacare taxes and over 43% post). Capital gains would be paid on a mark-to-market basis. If you bought a stock for $100 and it appreciated to $200 at the end of the year, but you held onto it, you would still owe $40 in taxes.

Doesn’t that sound pleasant?

Oh, and since tax-exempt investors would supposedly get a windfall from higher share prices, the AEI plan would claw back that benefit by taxing their bond income at 15%. Yup, you would now pay taxes in your IRA.

A less radical approach has been developed by Alan Viard of the right-of-center American Enterprise Institute and Eric Toder of the left-of-center Urban Institute. They would cut the corporate rate to 15%, and pay for it by taxing dividends and capital gains at the same rate as ordinary individual income. For the richest households, that is currently 39.6%, whereas dividends and capital gains are currently taxed at up to 23.8%. This helps rectify many flaws in the current tax code: the double-taxation of corporate profits, the bias for companies to issue debt rather than equity and widespread special breaks that distort the allocation of capital.

Like Mr. Ryan’s plan it largely eliminates the incentive to move operations or profits abroad in search of lower rates. Moreover, by raising the tax American investors pay on foreign dividends, it effectively shifts some of the U.S. tax burden away from American companies and workers and toward foreign competitors that tap American capital, without the threat of being labeled an illegal subsidy or tariff…

Tax-exempt investors such as pension funds would enjoy a windfall from higher share prices which the authors would claw back by taxing their bond income at 15%.

Jeremy Jones, CFA

Jeremy Jones, CFA is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Jeremy is a contributing editor of youngresearch.com.